Two delusions characterized the Great Crash of 2007-2008 which wiped $5 trillion off global GDP and $30 trillion off world stock markets, according to risk analyst Didier Sornette, author of ‘Why Stock Markets Crash: Critical Events in Complex Financial Systems’.

1. It could never happen: we had supposedly entered the age of “economic moderation” buttressed by never-ending growth, low unemployment and low financial volatility otherwise known as the ‘Goldilocks economy’—not too hot, not too cold, but just right.

2. We couldn’t possibly have seen the Crash coming: it was a rare ‘Black Swan’ event, an unpredictable outlier, a freak wave of economic destruction.

While the first myth has been comprehensively debunked, the second myth persists among economists, central bankers and policymakers around the world, the French economist told TEDGlobal 2013 conference in Edinburgh. We were somehow helpless in the face of “the wrath of the Gods…there was no responsibility.” See the TED Talk below – well worth a look.

However while this earthquake was, to a certain extent, a forseen event – remember Japan has a history of earthquakes – the damage to the nuclear power station was not. Some commentators have likened this to a Black Swan – see previous posting: 2011 Black Swans. The Black Swan has three characteristics:
1. its unpredictability;
2. its massive impact; and
3. after it has happened, our desire to make appear less random and more predictable than it was.

One wonders if this disaster has given the US Federal Reserve a key reason to undertake further Quantitative Easing 3 (QE3)?

A few days have past since my last post – had another spell at the beach with family before heading back to Auckland. Anyway Bernard Hickey wrote a nice piece on the NZ Herald website today with regard to Black Swans.

No doubt you would have come across the book entitled “The Black Swan” (2007) by Nassim Nicholas Taleb. He describes a black swan as highly improbable event with three principal characteristics:1. its unpredictability;
2. its massive impact; and
3. after it has happened, our desire to make appear less random and more predictable than it was.

Nassim Nicholas Taleb could see the banking crisis being realized, and this quote from “The Black Swan” explains partly the rationale for the current environment. Remember it was written when the world was awash with cheap credit and leaders were content with what was happening.

“So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks – when one fails, they all fall. The increased concentration among banks seems to have the effect of making financial crises less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogeneous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur I shiver at the thought.” Page 225-226
2011 – Black Swans

Hickey mentions the following in his piece:* Irish Politics – with a likely change of government there is the probablity that holders of Irish bonds will suffer losses and subsequently put pressure on UK and German banks* Chinese inflation – with pressure on prices there could be social unrest as lower income groups grapple with the cost of living* Aussie house prices – already depressed in Queensland, Sydney and Perth this could mean lower volume of imports from NZ* Higher oil prices – conflicts in the Middle East could lead to supply pressures* Kiwis stop spending – still a lot of debt around and deleveraging.

A couple of my predictions for 2011

* US Fed goes for QE3 – Quantitative Easing No. 3 – as the banks once again get into trouble
* Gold hits US$1,700 an ounce as investors run for cover
* Reserve Bank of New Zealand maintain their expansionary stance and don’t increase interest rates until September
* Ireland win the Rugby World Cup